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Don’t Buy China’s Growth Mirage

John Lee

The common wisdom on China’s rapid and relentless flow of rural-to-urban migration is that it’s the sustainable driving force behind the country’s high rates of investment, infrastructure building and overall economic growth. If that is the case, will Beijing’s intention to ‘slam on the brakes’ slow down the rate of Chinese urbanisation?

That depends on whether the common wisdom is correct. If it is, then the answer is a resounding ‘yes’. But despite the near consensus among China analysts, Chinese urbanisation is actually a much weaker driver of fixed investment in the economy than we presume. In fact, even if Beijing succeeds in ‘slamming on the brakes’, the rate of urbanisation in China will be largely unaffected.

How can this be? After all, the narrative that rural-to-urban migration is driving fixed investment, and therefore GDP growth, in China is an intuitive one. Over the past 30 years, China has experienced the largest and most rapid urbanisation in world history. The number of Chinese living in urban areas has increased from 17.8 per cent in 1978, to 40 per cent in 2003, and is around 47.5 per cent currently. While it took China 25 years to reach the 40 per cent mark, it took Japan 30 years, the US 40 years, France 100 years, and Britain 120 years. Surely a tighter monetary and lending policy will inhibit the rapid construction of infrastructure required to meet the demands of rapid urbanisation.

The problem is, the common wisdom assumes that investment decisions in China’s economy are primarily driven by the basic laws of supply meeting demand—in this case, that urbanisation is driving the relentless construction of roads, buildings, modern housing, ports etc. In truth, rural-to-urban migration is having less and less influence on the rising levels of fixed and asset investment activity occurring throughout the country.

The first thing to realise is that while urbanisation in China has been advancing at only 1-2 per cent each year for the past decade, fixed investment as a proportion of GDP has risen from around 30 percent in 1992, to 40 percent in 2000, to almost 60 percent in 2010. The Chinese state-led economy is clearly addicted to fixed investment to drive growth, given poor rates of domestic consumption—and given the high savings rate that is driven by the lack of social safety nets, such as an old age pension, negative real interest rates on bank deposits for its citizens, and an under-appreciated yuan, which makes exports more expensive—and, more recently, given the devastation to its export markets following the GFC. This is reflected in the astonishing increase in bank loans to Chinese companies over the past decade; rising from around US$240 billion in 2000, to US$750 billion in 2008, to US$1.4 trillion in 2010.

Over three quarters of these loans are lent to state-owned companies (SOEs), who then plough the cheap capital into fixed investment (especially infrastructure) projects; or else into speculating on property or in one of the two Chinese stock exchanges. This has, in turn, fuelled a frenzy of private sector speculation in both property and stocks over the past few years—and constitutes the current reasoning behind Beijing’s desire to rein in loose monetary and lending policy. Indeed, a recent study conducted by the People’s Bank of China indicated that around a quarter of homes purchased in the first three months of 2010 in Beijing are for investment and speculation purposes. In ‘hot’ regions such as Tongzhou district and Wangjing area, the figure is closer to 50 per cent.

Moreover, local officials who administer the bulk of the country’s capital are rewarded for meeting growth, rather than profit, targets—it doesn’t matter if buildings are empty and roads are rarely used. It is no wonder that Chinese economists estimate that non-performing loans owned to state-owned banks by local SOEs—which are not included in Beijing’s set of centralised financial accounts—could amount to $US1.5-2 trillion. Local officials also collude with local property developers in order to exploit the dramatic rise in property prices that is driven by asset speculation, rather than genuine demand.

The point is that the exponential rise in fixed investment in the Chinese economy—and its subsequent consumption of commodities such as iron ore—has much less to do with rural-to-urban migration than analysts assume.

Second, even though there are currently around 600 million Chinese in urban areas, between 150-200 million of these are migrant labourers still subject to the household registration system (hukou). This means that rural-born Chinese, working in cities, effectively receive lower wages, benefits and state support. Although they flock to cities in order to find work, the vast majority will never enjoy the luxuries of city living that we associate with urbanisation. In other words, a large proportion of China’s ‘urban’ population play little part in driving the exponentially increasing rates of investment activity taking place in the urban economy.

Beijing’s plan to slow the rate of lending in the Chinese economy will have little effect on the rate of Chinese urbanisation since rural-to-urban migration has become a much less significant driver of the recent China economic story than is commonly believed. Many will be surprised that, even as capital lending and fixed investment has increased exponentially, local officials in urban areas have successfully petitioned central authorities to slow the rate of urbanisation given that real unemployment in urban China was over 10 per cent even before the GFC.

The implications are not trivial. For example, the upshot for Australia is this: the narrative that ongoing urbanisation in China will sustain the current commodities boom for generations is seductive but flawed. In the words of Chinese Premier Wen Jiabao, China’s growth strategy is “unbalanced, unsustainable, uncoordinated and unstable.” This provides a (transient) silver lining for commodity exporters such as Australia. But if China succeeds in correcting these flaws, then the romance between Australian mining companies and the Chinese economy will wane.

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